Assessment and Mitigation of Risks in the Participatory Financing Arrangements

As discussed in Chapter 4 , participatory modes of Islamic financingIslamic financingparticipatory modes of including MusharakahMusharakah and MudarabahMudarabah are widely accepted as the ideal modes of financingFinancing, ideal modes of among the jurists of Islamic bankingIslamic bankingjurists of and financeIslamic bankingfinance. However, paradoxically, these are not the most popular modes of financing in practicePractice because the practicePractice of these modes in Islamic bankingIslamic bankingmodes in is constrained by several factors. Therefore, Islamic banksIslamic banking are applying the adapted variants of MusharakahMusharakah. Islamic banksIslamic banking adapt the participatory financingParticipatory finance to make these fit for SME financingSME financing, corporate financingCorporate financing, consumer financingConsumer Financing (CF), and commodity operations financingCommodity Operations Financing (COF) within the embedded contractual variants of MusharakahMusharakah namely diminishing MusharakahDiminishing Musharakah (DM) and running MusharakahRunning Musharakah (RM), while pure MusharakahMusharakah and MudarabahMudarabah are not applied in practicePractice. Moreover, Islamic banksIslamic banking use extensive procedures for the assessmentAssessment and mitigation of the underlying risksRisk to ensure the viability of MusharakahMusharakah, viability of-based financingFinance arrangements. This chapter provides insights into the procedures adopted by Islamic banksIslamic banking for assessing and mitigating the underlying risksRisk associated to the participatory financingParticipatory finance, particularly the riskRisk induced by asymmetric informationAsymmetric information including adverse selectionAdverse selection and moral hazardsMoral hazard.